STRATEGIC MANAGEMENT AND FIRM PERFORMANCE

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CHAPTER 3: RESEARCH FRAMEWORK AND HYPOTHESES

INTRODUCTION

This chapter presents a detailed account of the research framework and hypotheses of the study. The problem statement of the research is highlighted, followed by the research framework, based on a synthesis of extensive theoretical and empirical studies presented in Chapter 2 as well as in this chapter. The research hypotheses formulated to direct the research questions are also presented. The final part summarizes the major points presented in this chapter.

PROBLEM STATEMENT

The Ethiopian financial industry that had been active in the 1960s and early 1970s was nationalized by the socialist regime in 1975. The industry subsequently came under total ownership of the government from 1974 to 1991 (Bezabeh & Desta, 2014). After the change of government and the adoption of a free market system in 1991, the financial industry once again opened up to private investors in 1994. New Banking and Insurance Proclamations No. 84/1994 and No. 86/1994 respectively were promulgated. Existing government-owned banks and the national insurance company gained managerial autonomy. The new proclamations allowed domestic investors to engage in both banking and insurance businesses. However, foreigners were not allowed to also participate. As a result, in part the operations of banks and insurance companies have been limited to major urban areas (NBE, 2014/15), signifying low market coverage and penetration. The financial industry is still in its infancy, operating under a strict regulatory environment (EEA, 2011; Bezabeh & Desta, 2014). Even though the coverage and penetration levels are still low compared to many African countries, there have been surges in revenues of both banks and insurance companies since the liberalization of the financial services industry in 1994.
Many empirical studies have investigated the possible explanations for the performance variations of firms based on industry structure or Porter’s five-forces framework (referred to as industry effects of industry factors) and firm specific resources and capabilities (referred to as firm effects), particularly in the context of developed economies. Studies investigating the relevant situation in developing economies have been limited (Karabag & Berggren, 2013; 2014). Similarly, there have been many empirical studies on the mediating effect of competitive advantage between firm effects and performance variation (Barney 2001; Ray, et al., 2004; Newbert, 2008; Tuan & Yoshi, 2010; Gaya, et al., 2013; Ahmadi, et al., 2014). Many studies did not consider the mediating effect of competitive advantage between industry effects and firm performance and firm effects and firm performance (Spanos & Lioukas, 2001; Rivard, et al., 2006; Kim, et al., 2008; Sigalas & Economou, 2013), especially in the context developing economies such as Ethiopia.
The main research problem of this study therefore was to use the top management perceptions to investigate the industry and firm effects on the performance of financial service firms through the mediating effect of competitive advantage, in the regulated industry in the developing economy of Ethiopia.
The research specifically addressed the following sub-questions:
To what extent do industry effects predict competitive advantage, and the performance of financial service firms in Ethiopia?
How do firm effects explain the competitive advantage, and the performance of financial service firms in Ethiopia?
How does competitive advantage contribute to the performance of financial service firms in Ethiopia?
To what extent does competitive advantage mediate the relationship between industry effects and the performance of financial service firms in Ethiopia?
To what extent does competitive advantage mediate the relationship between firm effects and the performance of financial service firms in Ethiopia?

RESEARCH FRAMEWORK

Differences in competitive advantage and performance variations among firms have been the central research questions of scholars in the field of strategic management (Ma, 2000a; 2000b; Barney, 2001; Galbreath & Galvin, 2008; Gjerde, et al., 2010). Many scholars have been particularly interested in investigating the relative effects of industry-structure and firm-specific resources in explaining performance variations of firms (Porter, 1991; Mauri & Michaels, 1998; Spanos & Lioukas, 2001; Spanos, et al., 2004; Caloghirou, et al., 2004; Bou & Satorra, 2007; Kim, et al., 2008; O’Cass & Weerawardena, 2010; Holian & Reza, 2011; Houthoofd & Hendrickx, 2012; Karniouchina, et al., 2013; Karabag & Berggren, 2014; Takata, 2016).
Competitive advantage and performance variations among firms mainly depend on the advantages driven by industry structural forces – outward looking (Porter, 1980b; 1998; Luo, 1999; Goddard, et al., 2009; Chen, 2010) and internal firm resources – inward looking perspectives (Grant, 1991; Barney, 1991; 2001; Amit & Shoemaker, 1993; Kamasak, 2011; Bamiatzi, et al., 2016). Analysing the structure and characteristics of an industry assists in understanding the nature of competition, profitability of an industry, sources of possible competitive advantage and the performance of firms. According to Clelland, Douglas and Henderson (2006) industry factors determine the extent to which superior value creation can be converted into superior financial performance. Based on the theory of IO, Porter’s five-forces framework helps to explain and analyse industry structure and the degree of competition and to better understand the determinants of competitive advantage and performance variations of firms (Kim & Oh, 2004; Kim, et al., 2008; Arend, 2009; Carpenter & Sanders, 2009; Kamasak, 2011; Takata, 2016). The supporters of the RBV stipulate that the sources and drivers of competitive advantage and superior performance of firms depend on having unique resources and capabilities that are valuable and costly to imitate (Barney, 1991; 2001; Peteraf & Bergen, 2003; Barney & Hesterly 2010).
Although the two perspectives on competitive advantage differ, both are interested in explaining competitive advantage and firm performance (Ma, 2000b; Spanos & Lioukas, 2001; Hedman & Kalling, 2003; Galbreath & Galvin, 2008; Kamasak, 2011; Houthoofd & Hendrickx, 2012). Both the RBV and industry structure perspectives explain performance variations through the mediation of competitive advantage or strategy (Spanos & Lioukas, 2001; Kim & Oh, 2004; Rivard, et al., 2006; Kim, et al., 2008). Empirical studies revealed that both industry-based and resource-based competitive advantage explain the firm performance in the manufacturing as well service industries (Rivard, et al., 2006; Kim, et al., 2008; Galbreath & Galvin, 2008; Gjerde, et al., 2010). Based on a synthesis of the related literature, a research model was formulated as shown in Figure 3.1.
Source: Adapted from Kim, et al. (2008); Galbreath and Galvin (2008): Caloghirou, et al. (2004); Hooley, Greenley, Fahy and Cadogan (2001); Spanos and Lioukas (2001), Porter (1985; 1991; 1998), Kim and Oh (2004) and Bridoux (2004).
Each of the relationships between the constructs indicated in the above figure is discussed in detail under the research hypotheses.

RESEARCH HYPOTHESES

Industry Effects on Competitive Advantage and Firm Performance

The effects of industry in predicting firm performance have been well recognized and investigated by many scholars (Schmalensee, 1985; Dess, Ireland & Hitt, 1990; McGahan & Porter, 1997; Fahy, 2000; McGahan & Porter, 2003; Houthoofd & Hendrickx, 2012; Andonova & Ruiz-Pava, 2016; Bamiatzi, et al., 2016). Available literature predominantly indicates that industry effects on firm performance can be represented by either using Porter’s (1980) five-forces industry analysis (Pecotich, et al., 1999; Douglas & Ryman, 2003; Kim & Oh, 2004; Rivard, et al., 2006; Weerawardena, et al., 2006; O’Cass & Ngo, 2007; Galbreath & Galvin, 2008; Kim, et al., 2008; O’Cass & Weerawardena, 2010; Kamasak, 2011; Dulcic, Gnjidic & Alfrirevic, 2012; Karabag & Berggren, 2014; Altuntaş, Semerciöz, Mert & Pehlivan, 2014; Takata, 2016) or through industry concentration, entry and exit barriers and growth (Dess & Beard, 1984; Schmalensee, 1985; Spanos, et al., 2004; Caloghirou, et al., 2004; Clelland & Henderson, 2006; Short, et al., 2009; Houthoofd & Hendrickx, 2012; Bamiatzi, et al., 2016).
Based on Porter’s five-forces framework, which originates from the theory of IO, industry effects predict the impact of industry forces on a firm’s competitive position and its performance (Porter, 1991; Spanos & Lioukas, 2001; Kim & Oh, 2004; Galbreath & Galvin, 2008; Kim, et al., 2008; Houthoofd & Hendrickx, 2012; Takata, 2016). In investigating the perceptions of top management members regarding industry effects on firm performance this study employed Porter’s five-forces model. This model argues that industry structure determines the intensity of competition and it in turn affects the competitive position and advantage and therefore the performance of firms. The industry five-forces framework, as a comprehensive strategic analysis tool, is appropriate to investigate the effects of industry and firm-related factors on firm performance (Porter, 1991; 1998; Powell, 1996; Spanos & Lioukas, 2001). Rooted in the IO tradition, the five-forces framework also includes the traditional IO measure of industry concentration and the entry barrier and growth approach that considers industry as its unit of analysis. Porter’s structural analysis using the five-forces framework helps to examine the extent of industry competition in relation to a firm’s conduct, while the IO-SCP based view, which uses quantitative data, cannot capture managerial perceptions in addition to its inability to comprehensively explain and measure industry structure (Pecotich, et al., 1999; Molina, Pino & Rodrıguez, 2004). The industry effects measured in terms of the five forces, namely the threat of new entry, bargaining power of buyers, bargaining power of suppliers, rivalry among existing firms and threat of substitute products, determine the extent of competitive advantage and profitability of firms independent of firm effects (Spanos & Lioukas, 2001; Kim & Oh, 2004; Rivard, et al., 2006; Arend, 2009; Kim, et al., 2008; Porter, 2008; Takata, 2016). It is thus applied to analyse the intensity of competition and explain performance both at industry and firm levels (Porter, 1998; 2008).
Many empirical studies reveal that industry effects account in the range of 3 to 20% of firm performance (Schmalensee, 1985; Powell, 1996; Roquebert, et al., 1996; McGahan & Porter, 1997; McGahan, 1999; Chang & Singh, 2000; Gonzalez-Fidalgo & Ventura-Victoria, 2002; McGahan & Porter, 2003; Short, et al., 2007; Galbreath & Galvin, 2008; Short, et al., 2009; Tarziján & Ramírez, 2010; Houthoofd & Hendrickx, 2012; Karabag & Berggren, 2014; Andonova & Ruiz-Pava, 2016). Further studies by Spanos and Lioukas (2001), Rivard, et al. (2006) and Kim, et al. (2008), employing the complementary view of industry and firm effects using Porter’s five-forces model and RBV, revealed that firm performance variations could be explained by both firm and industry effects. Intense competition, the high bargaining power of both customers and suppliers, the low level of entry barriers with high levels of substitute products result in a negative impact on firm performance (Porter 1980; 1985; O’Shannassy, 2008). Powell (1996) argues that low levels of competition result in inefficiencies and poor performance, which could in turn manifest in a negative impact of industry structure on firm performance. In contradiction to this argument, Kim and Oh (2004) assert that a high level of bargaining power and the intensity of competition oblige firms to examine various strategic options that lead to better competitive advantage than that of their rivals.
Even though industry forces generally affect firm performance negatively (Takata, 2016), the influence of all industry factors on competitive advantage and firm performance particularly in a dynamic environment, cannot be in the same direction (O’Shannassy, 2008). Dulcic, et al. (2012) examined the impact of Porter’s five-forces on Croatian medium and large firms operating in the food and beverage industry using the industruct measurement scale developed by Pecotich, et al. (1999) for the measurement of industry structure. Their findings confirm that the relationship between industry structure and firm performance is significantly positive. They further argued that there could be a positive or negative relationship depending on the dynamic nature of the industry and its time-specific influences on firms. Barney and Clark (2007) argue that the industry structure explanation of performance variations can be applicable in an oligopoly or regulated market settings; while the RBV explanation can be employed in a competitive market situation and when there are no industry entry barriers. In line with this argument, a study in India comparing firm effects and industry effects during the command and control phase (from 1980-1981 and 1984-1985), transition period (1985-1986 to 1990-1991), and liberalization period (from 1990-1991 to 2005-2006) where financial and legal reforms had been undertaken, reveals that industry effects have a greater contribution to performance variations of firms in the manufacturing sector (Majumdar & Bhattacharjee, 2014).
Another study by Spanos and Lioukas (2001) in Greece indicates that industry effects measured using rivalry among competitors and bargaining power of suppliers contributed significantly and marginally significantly to market performance and profitability with direct and negative effects respectively. Douglas and Ryman (2003) found that the bargaining power of buyers and rivalry among existing firms had negatively affected hospital service performance in the USA. Consistent with the theory of industry competitive forces, Galbreath and Galvin (2008) identified that some of Porter’s five forces had significant negative effects on the performance among service firms in Australia. Moreover, Rivard, et al. (2006) did a study on the role of IT on business performance using a sample size of 96 respondents (CEOs) of SMEs in the province of Quebec, Canada, employing both Porter’s five-forces framework and the RBV perspectives. Their findings indicate that industry forces directly and negatively affected firm performance as measured by market performance and profitability, though its effects declined after the command and control phase. In Turkey, Karabag and Berggren (2014) indicated the significant role of industry structure in affecting firm performance more than firm effects. Empirical evidence revealed that industry effects could influence firm performance either positively or negatively depending on the competitive nature of an industry (Pecotich, et al., 1999).
Therefore, based on the theoretical framework discussed in Chapter 2, section 2.3, and supported by a large body of empirical evidence, the following null hypothesis (H10) and alternative hypothesis (H11) are postulated:
H10: Industry effects do not influence the performance of financial service firms in Ethiopia.
H11: Industry effects influence the performance of financial service firms in Ethiopia.
Industry structure, operationalized and measured using the aggregate effects of the five-forces framework (Pecotich, et al., 1999; Spanos & Lioukas, 2001; Galbreath & Galvin, 2008; Porter, 2008; Carpenter & Sanders, 2009; Takata, 2016) could result in generating industry-based advantage (Grimm, et al., 2006). For Porter (1991), the true source of competitive advantage could stem from a firm’s proximate environment. In addition to analysing its effects on the industry environment, the five-forces model shapes the actions and sources of the competitive advantage of firms (Pecotich, et al., 1999; O’Shannassy, 2008). The increasing intensity of the industry forces drives firms towards increased cost or differentiation advantages over their competitors that would further lead to above average returns (Porter, 1980b; 1985). Firm performance expressed in terms of profit is part of the competitive advantage or value captured by a firm as a result of its bargaining process with its internal and external forces (Bowman & Ambrosini, 2000; Coff, 2003; Bowman
& Ambrosini, 2007; Barney & Clark; 2007). The competitive advantage of a firm and thus its profit depends, among many factors, on the bargaining powers of industry forces for better benefits (Porter, 1998; Coff, 1999; 2003; Bowman & Ambrosini, 2000; O’Shannassy, 2008) and isolating mechanisms, entry barriers (due to legal and/or firm specific VRIO resources) and imitation (Porter, 1980b; Grant, 1991; Barney, 1991; Teece, et al., 1997; Makhija, 2003; Lepak, Smith & Tylor, 2007; Barney & Hesterley, 2010; Ritala & Ellonen, 2010). In order to gain competitive advantage and achieve superior firm performance, a firm should have an attractive relative position in an industry stemming from either a cost or differentiation advantage (Porter, 1991; 1998; Juga, 1999; Fahy, 2000; Ritala & Ellonen, 2010).
An empirical study by Gjerde, et al. (2010) using a large sample size of firms listed on the Oslo Stock Exchange revealed that the combined effects of both industry-based and resource-based competitive advantages predicted over 20% of firm performance, measured using stock market returns. Their finding further suggests that resource-based advantages had a three to four times higher effect than industry-based advantage. Even though most studies, done particularly in advanced economies, reveal that competitive advantage stems more from resource-based advantage than industry-based advantage, industry effects also influence the competitive advantage of firms. The findings of Camelo-Ordaz, Martı´n-Alca´zar and Valle-Cabrera (2003) on a study of 130 large Spanish firms indicated that competitive advantage is not only the result of firm resources and capabilities, but also depends on effects of the competitive environment. A survey in Australia using a sample of 293 drawn from different industries engaged in export businesses, revealed that the perceptions of competitive intensity, measured using Porter’s five-forces framework, influenced the export performance, strategic posture and adaptation of firms (O’Cass & Julian, 2003). Similarly, a survey result using data collected from 180 firms operating in different industries in Austria indicated that competitive intensity negatively affected the type of strategy a firm pursued (O’Cass & Ngo, 2007). More importantly, following the study of Schmalansee (1985) on the relative effects of firm, market structure and market share in predicting firm profitability, Powell (1996) indicated that about 80% of the variation in firm profitability was not related to industry factors. This encouraged them to further investigate the effects of possible intervening or mediating variables between industry effect and firm performance (O’Cass & Weerawardena, 2010). They further argue that even though the theoretical discourses on industry structure and firm resources have been advancing well in the past, few empirical studies have emerged. Moreover, restricting competition among firms, whether it originates from government or surfaces as a result of collusions, negatively affects the competitive advantage and profitability of firms (Makadok, 2010).
Considering that the financial services industry in Ethiopia is excessively regulated and protected from foreign competition, managements’ perceptions of industry effects could affect the competitive advantage and performance of firms. In this regard, Waktola (2015) contends that banks in Ethiopia concentrate more on short-term gains such as earnings per share rather than focusing on crafting long-term directions that ensure a sustainable competitive advantage. He further argues that the legal barrier and prohibition of foreign banks to operate in the financial services industry, besides negatively affecting competitiveness, has created complacency and short-sightedness among commercial banks in Ethiopia. Following the theoretical underpinnings covered under Chapter 2, section 2.3, and the empirical studies discussed above, a null hypothesis (H20) and alternative hypothesis (H21) are formulated as follows:
H20: Industry effects do not influence the competitive advantage of financial service firms in Ethiopia.
H21: Industry effects influence the competitive advantage of financial service firms in Ethiopia.

Table of Contents
Abstract
Acknowledgement
Abbreviations and Acronyms
List of Tables
Lists of Figures
CHAPTER 1: ORIENTATION AND BACKGROUND
1.1 INTRODUCTION
1.2 IMPORTANCE OF SERVICES AND BACKGROUND INFORMATION ON THE FINANCIAL SERVICES IN ETHIOPIA
1.3 THE RESEARCH CONTEXT
1.4 STATEMENT OF THE RESEARCH PROBLEM
1.5 RESEARCH OBJECTIVES
1.6 SCOPE OF THE STUDY
1.7 SIGNIFICANCE OF THE STUDY
1.8 DEFINITION OF TERMS
1.9 ORGANIZATION OF THE THESIS
CHAPTER 2: THEORETICAL FRAMEWORK AND LITERATURE REVIEW
2.1 INTRODUCTION
2.2 STRATEGIC MANAGEMENT AND FIRM PERFORMANCE
2.3 INDUSTRY STRUCTURE
2.4 CRITIQUE OF THE STRUCTURE-BASED VIEW AND FIVE-FORCES MODEL
2.5 THE RESOURCE-BASED VIEW
2.6 COMPETITIVE ADVANTAGE
2.7 FIRM PERFORMANCE
2.8 COMPETITIVE ADVANTAGE AND PERFORMANCE VARIATIONS OF FIRMS . 65
2.9 COMPLEMENTARY VIEW OF PORTER’S FIVE-FORCES FRAMEWORK AND THE RBV
2.10 EMPIRICAL EVIDENCE OF INDUSTRY EFFECTS AND FIRM EFFECTS ON FIRM PERFORMANCE
2.11 CHAPTER SUMMARY AND LITERATURE GAP
CHAPTER 3:RESEARCH FRAMEWORK AND HYPOTHESES
3.1 INTRODUCTION
3.2 PROBLEM STATEMENT
3.3 RESEARCH FRAMEWORK
3.4 RESEARCH HYPOTHESES
3.5 CHAPTER SUMMARY
CHAPTER 4: RESEARCH DESIGN AND METHODOLOGY
4.1 INTRODUCTION
4.2 ONTOLOGY AND EPISTEMOLOGY OF THE STUDY
4.3 RESEARCH DESIGNS
4.4 SAMPLING METHOD AND SAMPLE SIZE
4.5 DATA COLLECTION AND ANALYSIS TECHNIQUE
4.6 RESEARCH ETHICS
4.7 CHAPTER SUMMARY
CHAPTER 5: DATA ANALYSIS AND RESULTS
5.1 INTRODUCTION
5.2 SAMPLE CHARACTERISTICS AND RESPONSE RATE
5.3 DATA CLEANING AND PREPARATION
5.4 EVALUATION OF THE MEASUREMENT MODEL RESULTS
5.5 STRUCTURAL MODEL EVALUATION
5.6 CHAPTER SUMMARY
CHAPTER 6: DISCUSSION, CONCLUSIONS AND RECOMMENDATIONS
6.1 INTRODUCTION
6.2 DISCUSSION OF THE RESULTS
6.3 CONCLUSIONS
6.4 RECOMMENDATIONS
Further research directions
List of References
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